The SNP's black hole

Posted by Scotland in Union288sc on May 06, 2015

Does the Scottish government face a £1.5bn black hole, even with Full Fiscal Autonomy off the table?

by John McLeod

The SNP has been forced to back-track on its plan for Full Fiscal Autonomy (i.e. scrapping the Barnett Formula), as the Institute for Fiscal Studies has made clear that such a move would leave an immediate £7.6bn hole in Scotland's finances (see http://www.ifs.org.uk/publications/7722).

However, the Scottish Government's finances will soon be in even worse shape, according to research by Anthony Rush, a retired industrialist and former Council Member of CBI Scotland. Mr Rush has identified a £1.5bn black hole in the Scottish budget by 2016, which would present great difficulties for the SNP under the terms of the Smith Agreement (see www.harrisrush.com/scrap-smith).

To deal with the £1.5bn shortfall, the Scottish Government would have to raise tax, cut public spending or a combination of the two. Mr Rush points out that this could mean:

raising the basic rate of income tax from 20% to 23%

raising the 40% rate to 49% AND the 50% rate to 59%

cutting £1.5bn from public spending

OR a combination of tax rises and spending cuts.

These issues are not well-known or understood — they have gone unmentioned in the pre-election Scottish Leaders’ Debates — so Scotland In Union asked Mr Rush to explain the situation. He told us

‘There are several things which will happen in the next 12 months.

we will have a new government at Westminster

we will have a new government at Holyrood

the Smith Agreement will be put into Law

there will be a new Comprehensive Spending Review post 7 May.'

All of these will take place, but certain key factors are unlikely to change:

Scotland will be expected to run a balanced budget for Departmental Expenditure Limit (DEL) and Annually Managed Expenditure (AME) spending

The Block Grant will be calculated by the Barnett Formula

HM Treasury will still make payment of “Consequentials”

The current HM Treasury Funding Policy for devolved governments will remain unchanged

Because of population changes, Scotland’s population share in Barnett will reduce — (I estimate from 10.03% to 9.93%) — thus reducing the block grant

Scotland cannot go bankrupt.

Under current HM Treasury policy, there are very strict rules which apply if Scotland overspends. There are provisions which would give Scotland temporary relief but they require rapid restitution. Under the 2012 Act, Scotland will have, from 2016, powers to borrow up to £500m to cover overspends in DEL and AME — but only £200m in any one year. In my opinion, this will require Scotland to create a Scottish Reserve Fund.

The SNP manifesto proposes increased taxes on mansions and bankers' bonuses — which they could do as additional income tax on the 16,000 highest earning taxpayers — and an increase of the top rate to 50p. On the other hand, a Westminster government will increase the personal allowance. Taking account of attrition in the number of high taxpayers, these policies are unlikely to increase revenues for the Scottish Government — and may even reduce them.

The SNP also proposes a tobacco levy — not a devolved matter — which I am in favour of. They also wish to benefit from clamping down on tax evasion and avoidance. The effect on Scottish income tax payers would be limited and would definitely not exceed the proposed Air Passenger Duty (APD) give-away.

So the sum of all of this is that post-Smith, which won’t be until April 2016, the Scottish Government will be facing either large cuts in spending or increases in income tax (or both). It's very difficult to even estimate — my current thought is £1.5bn annually but that is still a shot in the dark.

I can empathise with the SNP wanting more fiscal autonomy, if for no other reason than that, in future Spending Reviews, Scotland’s population share will continue to reduce, as it has done each time since 1996.

Full Fiscal Autonomy would mean Scotland was entitled to all taxes collected in Scotland (including from the North Sea). Scotland would also make a payment to the UK Government for providing non-devolved services – let’s call it a Federal Charge - effectively Barnett in reverse.

However, I don’t think it is the answer, at least not in the short term.

The situation could be complicated by David Cameron’s announcement that a Tory government would not increase income tax for five years. This appears to give an SNP government a headache, if the implementation of the Smith Agreement forced it into raising income tax.

Ruth Davidson appears to disagree with me that the SNP will have to set a new tax rate in April 2016. Ruth was referring to the outcome of the Smith Commission. She thinks it unlikely that it will be in force before April 2016. In a way, I hope she is right because I think there needs to be more change, if it is to satisfy us here in Scotland.

But she didn’t mention the previous Calman Commission. Calman’s recommendations have been built into the 2012 revision of the Scotland Act and replace the old (unused) Scottish Variable Rate with a new provision. From 1 April 2016, the Scottish Parliament has to replace 10p of income tax with a rate they decide. It can be more than 10p or less — but not less by more than 10p — and it applies to all bands.

So when John Swinney comes to draft his 2016–2017 budget later this year, he has to set a new Scottish Income Tax Rate.

So let’s hypothesise that we get a majority Tory Government in Westminster. Two things will certainly happen:

no increase in income tax; and

cuts in public spending.

Added to which the Spending Review should cut the appropriate population rate factor in Barnett — from 10.03% to 9.93%, I estimate. So we can expect a cut in the Block Grant to Scotland. A Scottish Government of whatever colour would have to deal with this until the next UK General Election.

Ask yourself — what tools does the Scottish Government have?

It can raise taxes.

It can cut spending.

The Scottish Government has no other levers to hand. Moreover it is tightly ruled by Treasury Policy which is based on long standing convention — convention which pre-dates devolution. On top of this, they are permitted in any one year to borrow only a miniscule amount of public spending commitments.

In my opinion, devolution is proving as big a political blunder as the Poll Tax, and I do not wonder that there are many Scots who feel frustrated that Holyrood cannot deliver what they want. The truth is that it can’t and never will be able to, unless it is given more levers — more flexibility. Let’s be honest, Scotland is only a small part of the UK and is getting smaller. The population is only growing at half the rate of the UK, and the North Sea oil price crash is a tremendous loss of influence.

So a Scottish Government is between a rock and a hard place. Do they increase income tax or do they reduce public spending (unless they can get the rules changed)?

The SNP’s idea that they will lay siege to Westminster is somewhat medieval — crude, to say the least — especially because reasonable representatives should be able to negotiate a better arrangement. But the SNP are neurotic about independence. If they had any sense, they would recognise that the circumstances which banjaxed them the last time — no currency and no central bank — are still relevant. This is even more so the case now that the North Sea oil price has crashed and renewable energy is more uncertain.

The OBR can calculate Scotland’s GDP and share of debt. The ONS should be able to, but for some unknown reason doesn’t, calculate Scotland’s inflation. Surely Scotland can be set targets for containing debt/GDP and inflation within acceptable levels over the length of a Parliament? It would be up to the Scottish Government to argue for enhancement to meet special needs. How much more damage could they do, over and above the damage uncertainty does to the UK as a whole?

Frankly, I don’t think Scotland should have more tax raising powers. Look what has happened to Stamp Duty and APD. The Chancellor has trumped the Finance Secretary on both. What will new businesses think about Scotland, which may raise income tax — if they have the powers to raise it — when the UK has frozen it? The tax systems between Scotland and the rest of the UK must be aligned, not competing.’